Tue. Oct 26th, 2021

Today’s post looks at a Markov Process International article on the performance of Risk Parity funds through the 2020 Covid Crash.


I only met Markov Processes International (MPI) in June 2021, when I started listening to a podcast called Risk Parity Radio (RPR, more about them in a later post).

  • One of the first episodes of the podcast (which now reaches over 100 in total) suggested the document we are watching today.

He also revealed to me that there are several public risk parity (PR) funds in the United States.

  • Initially, I hoped that in addition to observing their covid breakdown performance, I could review them again in the follow-up post of our article on U.S. ETFs.

But it seems that they are mainly mutual funds and not ETFs.

  • The exception is RPAR, to which we will return.

Today’s paper corresponds to April 2020, at the heart of the crash, and is called Quant Funds in the Coronavirus Market Rout: Risk Parity.

It’s not that bad

Maximum withdrawal of RP 2020

The article begins by noting that RP is often blamed for increasing volatility during accidents, even those with real (rather than financial) external causes, as is the case with Covid.

  • Many also think that PR is obsolete and does not adapt to the recent (and current) low interest rate environment.

MPI defines RP as:

A multi-asset strategy designed to perform relatively well in all investment climates by balancing risk between its components. In general, the volatility of the portfolio is 10-15% and the allocation of bonds, due to the historically lower volatility of fixed income, is usually taken advantage of.

RP 2020 background table

They note that there is room for some discretion in implementation and therefore a variety of outcomes.

  • So some of RP’s public funds have gone well.

U.S. mutual funds do not disclose month-on-month positions, so MPI uses a technique they call Dynamic Style Analysis (DSA) within their Stylus platform.

  • They compare the funds with two 60/40 passive benchmark indices (national and global) and two S&P risk parity indices (10% and 12%).

RP provision for funds

In maximum provisions:

  1. The four reference portfolios had a maximum reduction between slightly better than -20% and slightly worse than -29%.
  2. Risk parity mutual funds lost between -13.4% (Columbia Adaptive Risk CRAAX) and -42.8% (Wealthfront Risk Parity WFRPX).
  3. On average, mutual fund losses of -22.2% were similar to the benchmarks in balanced portfolios and better than the selected risk parity strategy indices.
  4. AQR Risk Parity and Multi-Asset, as well as Putnam PanAgora, also had noticeably smaller rebates than any of the benchmarks.

SandP vs RP leverage

Implicit leverage of funds fell, on average, from 80% to at least 30% between the beginning of January and the week ending April 9th.th.

This forced sale (due to increased volatility) could have made the crash worse:

If the top of the estimated asset base ($ 400 million) was similarly leveraged and whether hedge funds and other risk allocation strategies behaved like mutual funds, does they represent a significant debt relief during a period of intense market stress that extends to more liquid and traditionally safe assets.

In practice, Fed interventions and / or rebalancing in the opposite direction meant that the accident did not go out of control and, in fact, ended very quickly.

Atypical values

Exhibitions for three collections

Columbia Adaptive Risk’s performance implies that it started to waste quite early, although its leverage seemed moderate to begin with. Wealthfront’s risk parity does not appear to have been leveraged at all, while the AQR risk parity fund appears to have behaved closer to the averages of mutual funds and risk parity indices.

The chart covers the VIX to make clearer the differences between these strategies.

  • MPI also does not reduce risk in terms of lower equity endowments.

Properly measuring, estimating and actively managing risk is key to risk parity to keep the volatility of each asset constant and to maintain an overall portfolio risk objective.

In an accident or on a flight to quality, many asset classes combine.

Much depends on recognizing or, better yet, anticipating a change in risk assets and the continuity of liquidity, which will allow funds to be deleveraged at an optimal time. Some risk parity funds can be pretty good for future expectations.

RP was fine during the Covid Crash.

  • This was also my own experience.
  • My maximum reduction was 12%, compared to 33% for the FTSE All-Share and 21% for the Global 60/40.

That’s all for today.

Mike Rawson

Mike is the owner of 7 Circles and a private investor living in London. He has been managing his own money for 35 years, with some success.

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